How to Avoid Taxes on Inheritance: A Guide for California and Washington Families

By Kevin Luu, Co-Founder and Chief Learning Officer. Reviewed on 2026-09-30.

There is no federal inheritance tax, and neither California nor Washington taxes heirs for receiving an inheritance. The taxes that actually shrink what a family passes on are the estate tax (Washington’s starts at a $3 million estate in the second half of 2026, the federal one at $15 million per person), income tax on inherited 401(k)s and IRAs, and, in California, property tax reassessment on an inherited home. You can reduce them with a few decisions: who owns your life insurance, which assets you leave versus give away while alive, how retirement accounts name beneficiaries, and how an inherited account is drawn down.

This guide is for dual-income W-2 families in California and Washington earning roughly $750,000 to $3 million, with young children. It covers both sides you may be on in the next decade: inheriting from your own parents, and planning what your kids will one day receive.

What “inheritance tax” means for a California or Washington family

An inheritance tax is charged to the person who receives assets. An estate tax is charged to the estate of the person who died, before anything is distributed. The IRS treats inherited money and property as generally not taxable income to you when you receive it (IRS, Gifts and Inheritances FAQ). California has no inheritance tax and no state estate tax (California State Controller). Washington’s tax is an estate tax, calculated on the Washington taxable estate (Washington DOR estate tax tables).

A handful of other states do tax heirs, and the rule that applies is usually the state where the person who died lived or owned real estate. If your parents live outside the West Coast, ask their estate attorney which rules apply to them.

So for a West Coast family the real list is:

• Federal estate tax: only above a $15,000,000 basic exclusion per person for 2026, made permanent by the 2025 tax law and indexed from 2027 (IRS, What’s New, Estate and Gift Tax). A married couple can shelter up to $30,000,000 combined with proper planning. The older claim that this drops to about $7 million in 2026 is obsolete.
• Washington estate tax: a $3,076,000 exclusion for deaths from January 1 to June 30, 2026, and $3,000,000 for deaths from July 1 to December 31, 2026. Rates for deaths on or after July 1, 2026 run from 10% to 20%.
• Income tax on inherited pre-tax accounts: traditional 401(k), 403(b) and IRA balances were never taxed, so the heir pays ordinary income tax on withdrawals.
• California property tax reassessment: under Proposition 19, an inherited home is generally reassessed to market value unless narrow conditions are met.

Capital gains tax is mostly absent from this list, and that is the most useful fact in the whole topic.

Why the step-up in basis matters more than any trust

When you inherit stock, a home or other property, your cost basis is generally its fair market value on the date of death (IRS Publication 551). Decades of growth generally go untaxed. If the same asset is given to you while the owner is alive, you generally keep their original basis instead, and you owe tax on all that growth when you sell.

California and Washington are both community property states. When a spouse dies, the full fair market value of community property, including the surviving spouse’s half, generally becomes the basis of the entire property (IRS Publication 555). For a couple holding appreciated RSU shares or a home bought 15 years ago, that double step-up can erase the built-in gain on both halves at the first death. Whether it applies depends on how each account and the house are titled, which is a question for your estate attorney.

Worked example: gift now versus inherit later

Assumptions (illustrative): your mother holds stock she bought for $200,000 that is now worth $900,000. You and your spouse live in California and have $900,000 of taxable income from wages. Federal figures are for 2026; California figures use the 2025 rate schedule, the latest published.

California taxes capital gains as ordinary income (FTB, Capital gains and losses). The lesson for families with parents who hold old, highly appreciated assets: lifetime gifts of those particular assets can cost the heirs a lot. Cash or high-basis assets are usually better candidates for lifetime gifts, and low-basis assets are usually better left at death. Your parents’ estate size decides whether that holds for them.

Washington families: the $3 million estate tax line is closer than it looks

Washington’s gross estate uses the federal definition (RCW 83.100.020), and federal law includes life insurance in the estate when the insured person holds ownership rights in the policy (26 U.S.C. 2042). That is the detail most Seattle-area families miss. The term policy bought for the kids counts toward the $3 million when the insured spouse owns it.

Worked example: an Amazon household in Bellevue

Assumptions (illustrative): a married couple with two children ages 4 and 7, household income $1.4 million. Assets: $2.4 million home equity, $1.1 million in 401(k)s, $1.8 million in brokerage and vested RSUs, and a $4 million term life policy on the surviving spouse’s life, owned personally by that spouse. The surviving spouse dies in the second half of 2026 (on or after July 1), leaving everything in trust for the children.

• Gross estate including the insurance payout: $2.4M + $1.1M + $1.8M + $4.0M = $9.3 million.
• Above the $3,000,000 exclusion: about $6.3 million, taxed at Washington rates of 10% to 20%. Even at the lowest 10% rate, that is about $630,000 of state estate tax or more, before deductions for debts and expenses reduce the taxable amount.
• If the same $4 million policy were owned from the start by an irrevocable life insurance trust (ILIT), it would generally sit outside the estate. The amount above the exclusion falls to about $2.3 million, and the tax drops by at least $400,000 (10% of $4 million, the lower bound).

No federal estate tax applies in this example, since the estate is well under $15 million. The planning is entirely about Washington. Two cautions: if an existing policy is transferred to a trust and the insured dies within three years, it is generally pulled back into the estate (26 U.S.C. 2035), so new policies are often bought by the trust directly. And ask your attorney whether your plan uses both spouses’ Washington exclusions or only the survivor’s.

California families with the same balance sheet owe no state estate tax, but the same ILIT logic applies once a couple’s estate, including insurance, approaches the federal $30 million combined level.

How to avoid taxes on an inherited 401(k) or IRA

You cannot avoid income tax on a traditional 401(k) or IRA you inherit, but you can control when you pay it. For deaths after 2019, most non-spouse beneficiaries must empty the account within ten years. A minor child of the account owner, a disabled or chronically ill person, and a beneficiary not more than ten years younger than the owner are “eligible designated beneficiaries” with more flexible rules (IRS RMD FAQs). In some cases, annual withdrawals are also required during those ten years, so confirm the schedule with the custodian in year one.

Worked example: a $1.2 million inherited IRA in a top-bracket year

Assumptions (illustrative): a Bay Area couple, a physician and a Genentech scientist, with $900,000 of taxable income inherits a $1.2 million traditional IRA. Federal brackets are for 2026; California uses the 2025 schedule. Growth is ignored to keep the comparison clean.

• Withdraw it all in one year: about $444,000 federal (all at 37%, since they are already above the $768,700 threshold) plus about $152,700 California. Total about $596,700, roughly 50% of the account.
• Spread it evenly, $120,000 a year for ten years: about $44,400 federal and $13,800 California each year, about $581,600 in total.

The difference is only about $15,000. For a family already in the top federal bracket, spreading withdrawals evenly helps less than people expect. The bigger levers are timing (taking larger withdrawals in a year with unpaid parental leave, a sabbatical or a career break), letting the account keep growing tax-deferred until near the deadline when income is high every year, and, for Washington residents, remembering that a 9.9% state income tax on AGI over $1 million begins January 1, 2028 (Washington DOR, Income tax). A Washington heir who would cross that line may prefer to draw more in 2026 and 2027.

An inherited Roth IRA follows the same ten-year clock, but qualified withdrawals are generally tax-free. That is one reason high-earning parents fund Roth accounts through a backdoor or mega backdoor Roth: the heirs inherit a tax-free account instead of a tax bill.

California homes: Proposition 19 is the inheritance tax nobody calls one

Before February 16, 2021, California parents could pass a home to their children and keep the low assessed value. Under Proposition 19, the parent-child exclusion now applies only to a family home or family farm. For a home, it must have been the parent’s principal residence and becomes the child’s principal residence, with a homeowners’ exemption filed within one year of the transfer. Even then, the exclusion is capped at the factored base year value plus $1,044,586 for transfers from February 16, 2025 to February 15, 2027; value above that is added to the assessment (California Board of Equalization, Proposition 19).

For a family inheriting a parent’s Palo Alto or Los Angeles house that they will not live in, the assessed value generally resets to current market value, and the property tax rises with it. That changes whether keeping it as a rental makes sense. Run the numbers on the reassessed tax before deciding to keep it.

The decisions that actually move the number

1. Who owns the life insurance. For Washington families and larger California estates, an ILIT can keep the payout out of the taxable estate.
2. Which assets you give and which you leave. Give cash or high-basis assets during life; leave low-basis stock and real estate at death to get the step-up. Gifts up to $19,000 per recipient for 2026 fall under the annual exclusion; larger gifts use part of the $15,000,000 lifetime exclusion and require Form 709.
3. Who is named on retirement accounts. Leaving a 401(k) to a minor outright is usually a mistake, because a court-supervised guardian may have to manage it. A trust named as beneficiary, drafted for retirement accounts, gives you control over timing.
4. How assets are titled. Community property titling can give a surviving spouse a full step-up on both halves.
5. How an inheritance you receive is drawn down. Map the ten-year window against your expected income, not against a straight line.

Common mistakes we see in high-income families

• Assuming “we’re under $15 million, so estate tax doesn’t apply” while living in Washington.
• Owning large term policies personally, which adds the face value to the estate.
• Parents gifting their oldest, most appreciated stock to children “to get it out of the estate” when the estate was never taxable.
• Beneficiary forms that still name a sibling, an ex, or “my estate,” which can force probate and lose flexibility.
• Cashing out an inherited IRA in the year of the funeral, on top of a $900,000 W-2 income.

What to document for your kids

Your children are under 12, so they cannot inherit outright and will not understand a trust document for years. What they can inherit is the reasoning: why the life insurance sits in a trust, why the house is titled the way it is, why the IRA goes to a trust instead of directly to them, and what you hoped the money would and would not be used for. Write that down in plain language next to the legal documents, and update it when the plan changes. As Kevin Luu puts it: “Your kids will inherit your money. Will they inherit your judgment?”

That written record is what the FamilyKnowledge® System is built to hold, and it is often the piece trustees and guardians wish they had.

Frequently asked questions

Do I pay taxes on money I inherit in California?

Generally no. Cash and property you inherit are not taxable income, and California has no inheritance or estate tax. You may owe income tax later if you inherit a traditional IRA or 401(k) and withdraw from it, or capital gains tax if you sell an inherited asset for more than its value at the date of death. An inherited home may also be reassessed for property tax under Proposition 19.

Does Washington have an inheritance tax?

No. Washington has an estate tax, which is paid by the estate before heirs receive anything. For deaths from July 1 to December 31, 2026, it applies to estates above $3,000,000, with rates from 10% to 20%. Because life insurance the person who died owned on their own life counts toward that total, many Washington families with young children cross the line without realizing it.

How can I avoid taxes on an inherited 401(k)?

You cannot avoid income tax on a traditional 401(k) or IRA, but you can choose when to pay it within the ten-year window most non-spouse heirs have. Large withdrawals fit best in lower-income years, such as a year of unpaid leave or a career break. A spouse who inherits has additional options, including rolling the account into their own. An inherited Roth account is generally tax-free if its rules are met.

Your next step

Pull three documents this month: the beneficiary forms on every retirement account, the ownership page of each life insurance policy, and your current will or trust. Check them against the five decisions above and bring the gaps to your estate attorney. Our questions to ask an attorney about inheritance can structure that meeting, and the step-by-step inheritance tax calculation walks through the math for your own numbers. If you name a trust on brokerage accounts, see how to name a trust as beneficiary. Age Five Family Office™ families work through this as part of estate planning and tax management, with the reasoning recorded through family governance.

This is general education, and the right move depends on your family’s full picture.

Written by

Kevin Luu

Co-Founder and Chief Learning Officer, Bright Advisers

Kevin has advised high-income W-2 tech and biotech families since 2015, and leads the education-first Age Five Family Office from Brea, California.

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